Institutional Framework for Attracting Foreign Direct Investment and the Importance of an Investment Promotion Strategy

Background

Investment promotion (a range of activities aimed at attracting FDI through public  image campaigns, marketing investment opportunities and assisting potential and existing  investors to set up and operate in the country) is only one of several tools available to  countries wanting to attract FDI. Countries attempt to create a favorable environment by  maintaining realistic exchange rates, guaranteeing repatriation of profits, assuring  access to imported components, and promising not to expropriate property without  compensation. They offer tax incentives and grants; provide industrial estates, export  processing zones, and other infrastructure; and attempt to simplify the bureaucratic  procedures facing potential investors. They also negotiate bilateral tax, trade and  investment treaties with countries from wherever investments might come.

Although attracting FDI requires efforts in many areas, investment promotion provides  an important mechanism for communicating all these efforts to potential investors, and  assisting the investors in implementing their projects. The rationale for public programs  to promote foreign direct investment in developing countries is built on the need to  overcome the effects of these market imperfections on investment decisions. For example,  it is thought that information about investment opportunities in unfamiliar environments  is either unavailable to outside investors, or may be too difficult to find under normal  circumstances. It is also sometimes thought that the factors constraining FDI are  particularly acute for smaller firms in industrial countries because they have less  capacity than larger firms to search for information. Smaller firms also may have less  experience with international business and thus may be more prone to overestimate risk in  foreign environments.

The need for investment promotion is bolstered by what is known about investment  decision processes. Studies of foreign investment decisions show that even the largest  firms do not systematically search for environment for investment opportunities. Rather,  such a search is often a response to problems from the external environment. While firms  follow strategies that can include foreign involvement, these strategies are usually  shaped within a narrow range of options. As a result, it has been documented that some  foreign investors tend to exhibit follow-the-leader behavior. That is, they respond to the  actions of competitors rather than acting as independent decision-makers searching the  whole environment for the best investment opportunities.

In these circumstances, promotional activities may have an impact on a firm's  decisions. There will be opportunities unidentified and countries uninvestigated because  there has been no significant reason to do so. Promotional activities can provide that  reason by introducing new information into the decision processes of firms, forcing them  to enlarge the set of options considered.

FIAS Approach and Terms of Reference

A. Institutional Framework for Investment Promotion

The central issue that host governments face in carrying out their investment promotion  efforts relates to the nature of the institutional framework that will execute these  efforts. In principle, there are two ways to structure an investment promotion agency: 1)  as a government organization; or 2) as a private sector organization:

1. A government could carry out investment promotion itself (directly as a part of its  administrative structure), but this approach has the disadvantage that the government  organization may be unable to acquire the skills required to manage the activity properly.  The required skills may reside in the private sector and attracting them to the public  sector may prove difficult, especially with the salary constraints typical of the public  sector. Another option is the creation of a "quasi-governmental" organization.  This involves a parastatal agency, funded (in total or to a large degree) by the  government but separated from the government ministries and public financial institutions.  This separation would create the image of an independent organization that is dedicated to  serving the interests of investors.
2. An alternative approach is for the government to delegate the management of investment  promotion activities to the private sector. This approach often has the disadvantage that  the private sector may not execute effectively those related activities, which are  traditionally government responsibilities.

Regardless of the approach that is chosen, there will be management issues with respect  to how the inherent disadvantages of either approach are to be overcome. In an attempt to  overcome these disadvantages, governments may search for the organizational approaches  that combine most effectively, the skills and resources of both the public and private  sector.

FIAS assistance in the development/strengthening of an institution capable of carrying  out an investment promotion strategy would focus on two aspects: the institutional  framework of the agency, and its internal structure and capacity.

Advice on the institutional framework for investment promotion would address the  following issues:

• The mandate of the agency - its role and functions, its clients - foreign or domestic  investors, or both;
• The legal status of the agency;
• Governance - external structure and linkages to the government and private sector;
• Staffing and skill base;
• Internal planning and management procedures; and
• Funding

FIAS could also identify the needs for additional technical assistance in the  implementation of the institutional framework and staff training. A report is usually  prepared on the findings and recommendations of FIAS and a seminar is organized to discuss  the recommendations and the issues related to their implementation.

B. Investment Promotion Strategy

A strategy provides a frame of reference and a program of work for the investment  promotion agency. In developing an investment promotion strategy, it is necessary to  determine the short- and long-term objectives of investment promotion and to find the  appropriate balance between investment promotion activities, taking into account important  factors such as the investment environment, the comparative advantages of the country, and  global developments and recognizing that these factors change over time. The development  of a strategy also entails understanding what to promote, where to promote, and how to  tailor and time the message to achieve maximum impact. In the case of Uzbekistan, the  strategy will emphasize "how to promote" and it will be necessary to understand  not only what a country has to offer, but also what foreign investors are seeking as  investment opportunities.

FIAS assistance on this matter would involve the following:

• A survey of existing and potential investors to get their views on the FDI environment  in a given country and the comparative advantages of that country;
• Development of a recommended strategic mix of investment promotion activities, taking  into account the quality of the business environment, the country's overall  development objectives – if articulated, factor endowments, and investors'  perceptions; and
• Identification of the key sectors that may be candidates for targeted promotion.

FIAS will prepare a report on the findings of the survey and other analytical work, along with recommendations for an investment promotion strategy. After the delivery of the  report, FIAS could organize a seminar to discuss the findings and recommendations as well  as to provide input on the approach for implementation.